Trade War Threatens Recession

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Washington, DC (Monday, July 29, 2019):

On July 19, 2019, the federal government released gross output (GO) for the 1st quarter 2019, and the 1.6% real-term growth — which was 30% lower than the 2.3% advancement from the previous period – strengthened the implication that the economic growth might be slowing.  Business-to-business (B2B) in the supply chain actually declined in the first quarter.

While corporate tax cuts and the elimination of some of the burdensome business regulations undoubtedly had positive effects on economic growth, the effects of tariffs and trade restrictions are significantly higher, as trade plays a much bigger role in the US and world economy. Trade accounts for more than 25% of spending in the US economy and nearly 60% of the global economy.

Whereas GO growth decreased in the first quarter after rising in the tree previous periods, GDP reversed direction after falling for three consecutive quarters and advanced at 3.1%, which was nearly 30% higher than the 2.2% growth rate from the fourth-quarter 2018.  But the decline in the value of the supply chain suggests that the rise in real GDP is temporary.

Total spending on new goods and services (adjusted GO) [1] exceeded $45 trillion by a small margin. In line with the GO indications, B2B spending declined 0.3% (0.4% in real terms) and consumer spending expanded 1.4% (0.5% in real terms), which was lower than the 2.2% consumer spending growth rate from the previous period.

Business — Not Consumers — Drives the Economy

Note:  Contrary to what the media says, consumer spending does not drive the economy, and does not represent two-thirds of the economy. Using GO as a better, more accurate measure of total spending in the economy, the business sector (B2B spending) is almost twice the size as consumer spending. Consumer spending is the effect, not the cause, of prosperity (Say’s law).

The continued slowdown in business spending suggests a potential economic slowdown and the end of the longest bull market since the Great Depression, if business spending growth stalls. However, the trend might still reverse on a potential resolution of the trade conflict as Trump Administration’s delegation is heading to China for the next round of trade negotiations.

Furthermore, the overall economy and markets are waiting in anticipation for the results of the Federal Open Market Committee meetings next Tuesday and Wednesday. The primary interest is whether the Fed will decide to counter its quarter-point hike from December 2018 and revert its target rate back to 2% to 2.25%, or go even further and announce a half-point interest rate reduction to June-2018 levels.

The fears of continued trade war with China has certainly influenced business spending slowdown. However, positive impressions from the upcoming trade negotiations with China and a potential Fed funds rate cut of up to half percent might alleviate some of the reservations, which could result in a renewed push to increase business spending in the second half of the year.

In addition to a lower growth of the overall GO, more sectors experienced a decline – five in the first-quarter 2019 versus only two in the fourth-quarter 2018. However, on the positive side, government spending rose only 1.5% in nominal terms at annual rates, which was the lowest growth rate in the past seven quarters.

GO is a leading indicator of what GDP will do in the next quarter and beyond. As David Ranson, chief economist for the private forecasting firm HCWE & Co., states, “Movements in gross output serve as a leading indicator of movements in GDP.”

Whenever GO is growing faster than GDP, as it did in most of 2018, it’s a positive sign that the economy is still robust and growing.  However, GO has grown at a slower pace than the GDP in the last two quarters.

The advance estimate of second-quarter GDP was released on July 26, 2019. As implied by the slower GO growth in the first quarter, the second-quarter GDP rose at 2.1% in real terms, which is 32% lower than the 3.1% advancement from the first quarter 2019.

Report on Various Sectors of the Economy

After growing at double-digit percentages and nearly doubling over four quarters, the Mining sector pulled back 7.2% in the fourth quarter 2018. Unfortunately, the Mining sector extended its decline and contracted more than 26% on an annualized basis for the first-quarter 2019. The Mining sector comprises only 1.6% of the entire Gross Output and the first-quarter decline has only a small impact on the overall economic output in the current period. However, the Mining sector is one of the early stages of production and often an early indicator of potential economic downturns in the near future.

Similarly, the Agriculture, forestry, fishing, and hunting sector – another early stage of production sector – also contracted 1.5%. Furthermore, Manufacturing – the second-largest segment with 17% share of Gross Output – declined 3.7%. One promising development within the Manufacturing sector was that production of Durable Goods increased 4%. Non-durable Goods declined 11.7%. Additionally, Transportation & Warehousing — another indicator of economic activity strength — also contracted 5.6%.

Among the expanding sectors, Construction – 4.6% share of GO – advanced at an annualized rate of nearly 12%, Educational services, health care, and social assistance, which accounts for 8.2% share of GO expanded 7.6%. Also, the largest sector that accounts for 19% of GO – Finance, insurance, real estate, rental, and leasing – expanded 2.2%.

Total government spending accounted for 10.6% of the total GO spending and increased 1.5% in the first-quarter 2019, which is significantly lower than the 3.5% growth in the previous quarter. This growth rate is the lowest since the second quarter 2017. While federal government increased 2.4%, state and local government expanded only 1.1%, which is less than one-third the 3.5% growth from the previous period. Additionally, the federal government grew more than state and local governments for the first time since the second quarter 2016.

Trade

Gross output (GO) and GDP are complementary statistics in national income accounting. GO is an attempt to measure the “make” economy; i.e., total economic activity at all stages of production, similar to the “top line” (revenues/sales) of a financial accounting statement. In April 2014, the BEA began to measure GO on a quarterly basis along with GDP.

Gross domestic product (GDP) is an attempt to measure the “use” economy, i.e., the value of finished goods and services ready to be used by consumers, business and government. GDP is similar to the “bottom line” (gross profits) of an accounting statement, which determined the “value added” or the value of final use.

GO tends to be more sensitive to the business cycle, and more volatile, than GDP. During the financial crisis of 2008-09, GO fell much faster than GDP, and afterwards, recovered more quickly than GDP. Still, it wasn’t until late 2013 that GO fully recovered from its peak in 2007. Until mid-2018, GO outpaced GDP, suggesting a growing economy.  However, since then GO has slowed dramatically, threatening the economic boom.

Currently Business Spending (B2B) Is Advanced at a Slower Pace Than Consumer Spending in both Nominal and Real Terms.

Our business-to-business (B2B) index is also useful. It measures all the business spending in the supply chain and new private capital investment. Nominal B2B activity pulled back 0.3% in the first quarter to slightly below $26 trillion. Meanwhile, consumer spending rose to $14.24 trillion, which is equivalent to a 1.4% annualized growth rate. In real terms, B2B activity declined at an annualized rate of 0.4% and consumer spending rose at 0.5%.

Trade

“B2B spending is in fact a pretty good indicator of where the economy is headed, since it measures spending in the entire supply chain,” stated Skousen. “The business activity slowed considerably in the 4th and 1st quarters, although it could be a temporary situation, depending on trade policy.”

About GO and B2B Index

Skousen champions Gross Output as a more comprehensive measure of economic activity. “GDP leaves out the supply chain and business to business transactions in the production of intermediate inputs,” he notes. “That’s a big part of the economy, bigger than GDP itself. GO includes B2B activity that is vital to the production process. No one should ignore what is going on in the supply chain of the economy.”

Skousen first introduced Gross Output as a macroeconomic tool in his work The Structure of Production (New York University Press, 1990). A new third edition was published in late 2015, and is now available on Amazon.

Click here: Structure of Production on Amazon

The BEA’s decision in 2014 to publish GO on a quarterly basis in its “GDP by Industry” data is a major achievement in national income accounting. GO is the first new output statistic published on a quarterly basis since GDP was invented in the 1940s.

The BEA now defines GDP in terms of GO. GDP is defined as “the value of the goods and services produced by the nation’s economy [GO] less the value of the goods and services used up in production (Intermediate Inputs or II].” See definitions at https://www.bea.gov/newsreleases/industry/gdpindustry/gdpindnewsrelease.htm

With GO and GDP produced on a timely basis, the federal government now offers a complete system of accounts. As Dale Jorgenson, Steve Landefeld, and William Nordhaus conclude in their book, A New Architecture for the U. S. National Accounts, “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare. Both are required in a complete system of accounts.”

Skousen adds, “Gross Output and GDP are complementary aspects of the economy, but GO does a better job of measuring total economic activity and the business cycle, and demonstrates that business spending is more significant than consumer spending,” he says. “By using GO data, we see that consumer spending is actually only about a third of economic activity, not two-thirds that is often reported by the media. As the chart above demonstrates, business spending is in fact almost twice the size of consumer spending in the US economy.”

Note: Ned Piplovic provided technical data for this release.

 

For More Information

The GO data released by the BEA can be found at www.bea.gov under “Quarterly GDP by Industry.” Click on interactive tables “GDP by Industry” and go to “Gross Output by Industry.” Or go to this link directly: BEA – Gross Output by Industry

For more information on Gross Output (GO), the Skousen B2B Index, and their relationship to GDP, see the following:

To interview Dr. Mark Skousen on this press release, contact him at [email protected], or Ned Piplovic, Media Relations at [email protected]

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[1] The BEA currently uses a limited measure of total sales of goods and services in the production process. Once products are fabricated and packaged at the manufacturing stage, the BEA’s GO only adds “net” sales at the wholesale and retail level. Its official GO for the 2019 1st quarter is slightly above $37.25 trillion. By including gross sales at the wholesale and retail level, the adjusted GO increases to nearly $45 trillion in Q1 2019. Thus, the BEA omits almost $8 trillion in business-to-business (B2B) transactions in its GO statistics. We include them as a legitimate economic activity that should be accounted for in GO, which we call Adjusted GO. See the new introduction to Mark Skousen, The Structure of Production, 3rd ed. (New York University Press, 2015), pp. xv-xvi.

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